A smart and simple way to save money on childcare is through a Dependent Care FSA – sometimes called a Dependent Care Assistance Plan (DCAP).
These accounts – provided by your employer – allow you to set aside pretax money from your paycheck to help pay qualified, out-of-pocket childcare costs like your nanny’s wages, daycare, preschool, summer camps, and before or after school programs.
If you do not have a Dependent Care FSA and one is available to you through your employer, you may want to take advantage of the open enrollment period to sign up and save some money on your childcare costs.
The funds may be used to cover care expenses for children under the age of 13 or who are incapable of self-care and live with you for more than half the year.
The maximum amount you can put into your Dependent Care FSA for 2022 is $5,000 for individuals or married couples filing jointly, or $2,500 for a married person filing separately.
That means, for a married couple, each parent can contribute $2,500 to their own Dependent Care FSA for a total of $5,000. This amount is set by statute and not adjusted annually for inflation.
Your employer can also choose to contribute to your Dependent Care FSA. However, the total employer and employee contributions to the account cannot exceed the maximum amounts allowed by the IRS.
Dependent Care FSAs and pandemic legislation
In 2021, the Dependent Care FSA limit was increased to $10,500 for single taxpayers and married couples filing jointly and to $5,250 for married individuals filing separately. This was part of the American Rescue Plan.
Typically, if you don’t spend your Dependent Care FSA funds by the end of the year, you lose that money. Although your employer may offer a grace period of a couple of months into the new year to use up funds.
However, due to pandemic legislation that aimed to help families with their childcare costs, your employer may allow you to carry-over your entire remaining Dependent Care FSA balance into 2022 and provide a grace period of up to 12 months following the end of the 2021 plan year to use those funds.
How to save on childcare with a Dependent Care FSA
Your contributions to a Dependent Care FSA are pre-tax, lowering your taxable income so you pay less in Social Security, Medicare, and income taxes. The savings can be significant depending on your federal tax bracket and state and/or local income tax rates.
Let’s take this example:
A married couple in New York with a household income of $250,000 and filing a joint return could save about $1,900 a year if they contributed the maximum amounts to their Dependent Care FSAs.
This calculation is meant to help you understand an estimate of tax liabilities but should not be used as a replacement for formal calculations and does not constitute the provision of tax or legal advice. The user assumes all responsibility and liability for its use.
Now is time to open or update a Dependent Care FSA
With annual open enrollment periods underway at many employers, you should check your Dependent Care FSA account balance and ask your human resources department how much can be carried over into next year. This will help you to determine if you need to exhaust your funds in 2021 or adjust your paycheck deductions next year.
You can only sign up for an account during open enrollment unless you have a qualifying life event, which may include changes to your:
- Employment status (including medical leave)
- Marital status (marriage, divorce, legal separation)
- Birth or adoption of a child
- Number of tax dependents
You have up to 30 days after the birth or adoption of your child to enroll in a Dependent Care FSA.
How a Dependent Care FSA works
You will determine how much you want to contribute to your Dependent Care FSA. That amount is then divided up, deducted evenly from each of your paychecks for the remainder of the plan year, and deposited into your account. You will pay your nanny as normal and then apply to be reimbursed from your account based on the wages you paid your nanny.
A couple of items to keep in mind:
- You can only be reimbursed for care that has already been received
- You can only receive reimbursements up to the amount that has already been deducted from your pay
You will likely need to complete a claim form and provide receipts or proof of payments. You may need to include:
- date of the expense (or service start and end dates)
- description of the service
- expense amount for reimbursement
- name, address, and social security number (or individual tax identification number) of your childcare provider
- dependent’s name and relationship to you
Clients of GTM Payroll Services will find a letter in their online portal that can be used for Dependent Care FSA reimbursements. They also have access to their payroll register as proof of payments. If you are a GTM client and need assistance, call us at (800) 929-9213 or email [email protected].
Legal pay required to use a Dependent Care FSA
You need to pay your nanny legally to take advantage of tax savings through a Dependent Care FSA.
Your nanny must claim the wages you paid to them – and that you are being reimbursed through the Dependent Care FSA – as taxable income.
Who qualifies as a childcare provider
As mentioned, Dependent Care FSA funds can be used to reimburse your expenses related to a nanny, daycare, preschool, summer camp, and before or after school programs.
Also, you can use these funds if you pay a relative to provide care as long as they are not claimed by you or your spouse as a tax dependent.
A Dependent Care FSA can cover expenses paid to a babysitter under the age of 19 as long as they are not your or your spouse’s child, stepchild, foster child, or tax dependent. To qualify as an eligible expense, the babysitter’s services must allow you to be able to work or look for work. A “date night” babysitter may not qualify as an eligible expense for a Dependent Care FSA.
Again, just like with a nanny, relatives and babysitters must claim this pay as taxable income.
A Dependent Care FSA cannot be used for a tutor as that is considered an educational expense.
If you are married, generally both you and your spouse must be employed or looking for work to be reimbursed for expenses. If a spouse can work but is a “stay-at-home” parent and you hire a nanny to help with childcare, you may not be able to cover those wages with a Dependent Care FSA.
A spouse who is a full-time student or is not physically or mentally able to care for themselves can be considered employed.
Using the Child and Dependent Care Tax Credit
You may also take advantage of the Child and Dependent Care Tax Credit when you file your personal income tax return. You could claim the credit if you paid someone to care for your child under the age of 13 so you could go to work.
For the 2021 tax year, the Child and Dependent Care Tax Credit for a family with one child increased from $3,000 to $8,000. For families with two or more children, the credit was raised to $16,000 from $6,000.
In past years, the amount of the credit was 20 percent of expenses so $600 for one child and $1,200 for two or more children. For your 2021 taxes, the amount of credit gradually decreases based on your family’s household income, but most should see some increased tax savings when applying the Child and Dependent Care Tax Credit.
Households with income below $185,000 will see a tax credit of 21-50 percent of expenses. If your household income is between $185,001 – $400,000, your tax credit is 20 percent. For households with income between $400,001 – $440,000 the tax credit starts to phase out.
You cannot use the Child and Dependent Care Tax Credit for the same expenses reimbursed through a Dependent Care FSA. It will only be applicable to the expenses that exceed your Dependent Care FSA contributions. For example, if you have two children and $16,000 or more in childcare costs, you can contribute $5,000 to a Dependent Care FSA and apply $11,000 to the Child and Dependent Care Tax Credit.
For a family with a full-time nanny, it could be very easy to use both the Dependent Care FSA and the Child and Dependent Care Tax Credit.
GTM can help
Looking to take advantage of a Dependent Care FSA and/or the Child and Dependent Care Tax Credit? But paying your nanny “off the books?” GTM can help. We can do back tax work to get you caught up on your nanny tax obligations and eligible for money-saving tax deductions. Then we will set up your nanny to be paid the right way so you’re compliant with tax, wage, and labor laws and avoid fines and penalties. Call us at (800) 929-9213 for a free, no-obligation consultation with a household employment expert or schedule time with us at your convenience.
Download The Complete Guide to Household Payroll
Get our complimentary guide and learn everything you need to know about paying your employees legally and filing your taxes the right way.